I Did the "Unthinkable" and Bought Facebook at $50

As easy as it is for investors sitting on the sidelines to write off Facebook's (NASDAQ: FB) massive post-earnings run-up as a missed opportunity, it could ultimately prove to be the wrong decision. Last week, I found Facebook's long-term growth story to be so compelling that I went ahead and bought shares at around $50.

Turning threats into opportunities The telltale sign that Facebook wasn't going to become the next MySpace was how it dealt with the "threat" of mobile. Last year, Wall Street was overly concerned that the explosive rise of mobile users would likely cannibalize Facebook's desktop-oriented business model. It wasn't until last quarter that the company officially put this concern to bed by showing the skeptics that its business is incredibly adaptable to change, despite its massive size.

Source: SEC filings.

The fact that 41% Facebook's advertising revenue came from mobile last quarter when it was nonexistent less than two years ago should give investors the confidence that Facebook is capable of reacting to and anticipating changes in technology and user behavior in short order. At the end of the day, adaptability is an essential quality for any technology company to posses, given the notoriously disruptive nature of technology in general.

The deal sealerWhen you've got 699 million users engaging on the site every single day, the growth opportunities are seemingly limitless. Let's name a few.

The company is reportedly gearing up to launch video ads within the News Feed, which, if all goes to plan, could equate to several billion in additional annual revenue. Additionally, there's massive potential for Facebook to leverage its existing user base in more creative ways than simply serving out more advertisements. I could easily see it entering the mobile payments business or perhaps even creating a commerce platform where the user becomes the customer.

The moral of the story is that Facebook will most certainly introduce more creative ways to monetize its ecosystem in the years ahead. Coupled with the fact that it's becoming more experienced with unlocking user insights and measuring ad effectiveness, it's all but certain that marketer interest will remain strong in the years to come.

Don't let the numbers scare you Behind its seemingly "stretched" valuation lies a business that's incredibly dynamic and led by perhaps the best CEO in the business. With a 99% approval rating on Glassdoor (and currently ranked the highest-rated CEO), Mark Zuckerberg has created a culture that its employees are openly embracing. With such great rapport among employees, it should come as no surprise that Facebook is also ranked the best place to work on Glassdoor.

As often is the case with amazing businesses, Facebook is expensive by conventional valuation metrics. Shares currently trade for 229 times trailing-12-month earnings and nearly 52 times forward earnings. What's more, the analyst consensus expects some pretty serious revenue growth in the years ahead. The consensus is that it will grow 2013 revenue by nearly 45% from 2012 levels, and by 2014, it is expected to rise by another 33% from 2013 levels. From this perspective, a lot of growth could already be baked into Facebook's current share price.

However, if you were to follow the numbers alone, you could end up missing the bigger picture: Facebook isn't a conventional business, and shouldn't be valued as one. Over the next decade, I expect investors to slowly realize how the facets of its business all play into the bigger picture. If everything goes well, Facebook has a good chance of becoming the greatest communications company the world has ever seen. With the right mindset and appropriate time horizon, you haven't missed the boat yet.

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What did you find compelling about the growth story for FB? The numbers should scare off anyone. So in a nutshell could you explain to us the following:

#1 On Valuation - How is it that the current price does not already include far more growth in gross revenue when the P/E is over 120 (177 to be more exact)?

#2 On growth potential - As they have yet to pay a dividend. This shows that there is not enough revenue at the P/E of >120 (177 again to be more exact) to cover both overhead and dividends. How do you equate increased revenue with no dividend or book value growth into stock value growth? After all they are now operating at a net margin of 9% ish. What makes one believe that they can be better managed at higher revenue?

#3 On revenue growth - Does anyone honestly believe that there is enough advertising capital available to pump up revenue to a sane P/E and provide a decent dividend?

#4 On Value - With a Book Value to Market Cap ratio that is so very tiny. Where is there room to grow?

I'm not trying to be a smart ass but I have read and read more and more hyped up claims that FB is a growth stock and I do not see fundamentals or revenue supporting a price over $18. Even if it were at $18 where is the actual growth of value? If they cannot increase book value or pay a dividend the ROI expectation is solely based upon hype and fantasy.

@smadi2012 - Below are a few articles I did back in early 2013 talking up Facebook's prospects, when the stock was significantly lower. The reason I'm only buying now is because I never got around to buying it earlier. It's been on my watch list for a long time.

@BB1963 - The stock is undoubtedly pricing in more growth for the future at current valuations, but I'm willing to wager that Facebook could potentially surpass these growth expectations over the next decade. It's not going to be a smooth ride, that's for sure.

Also, because Facebook is a growth company, I don't think conventional valuation metrics do the company justice. Can you really assign a concrete value to its culture, how it's an amazing place to work that energizes employees to do better, or how it's highly adaptable to change, despite being massive? On paper, Facebook looks overvalued, but there are what I believe to be very valuable intangibles (which lead to outperformance) that conventional metrics simply cannot incorporate.

Over the short-term, you may be successful on your short position and I wish you the best of luck. But I think in the next decade, time will humble us all.

Facebook is an intriguing company with pretty bright prospects. Thanks for sharing your perspective.

While I do think you are right that many standard valuation metrics are probably not totally appropriate for this "rule-breaker" of a stock, I strongly disagree with the inference that fundamental analysis is somehow not instructive in this case. The ONLY reason to invest in a stock, is because you believe that the discounted future cash flows will meet or exceed your required rate of return and grow shareholder wealth.

P/E, P/B, ROE, or ROIC measures may not be entirely useful yet, but reasonable forecasts for user growth, advertising rates, mobile saturation, etc. can inform key profitability, growth, and cash flow forecasts. Additionally, keeping an eye on trends in weighted average share count, preferred dividends paid, interest expense on debt, and stock-based compensation (to name a few) are still very useful when considering how much shareholders really stand to benefit from such heady (projected) revenue growth.

Many people also want to compare Facebook to Amazon, as neither are "conventional" businesses, and should be valued differently than "normal" companies. While I think there's some truth to that statement, there's also a misleading assumption there. It's long been known that Bezos has been sacrificing profitability for market share gains and supply chain efficiency for years, which suggests huge potential earnings power. Facebook, however, is reliant upon tremendous ad growth, impressive user retention and expansion, and adoption of premium member services, requiring a veritable perfect storm to help expand profitability to a point where earnings catch up to current valuation.

Simply saying this stock is "different" or "unconventional" strikes me as a particularly specious if it's not paired with some simple projections of revenues, COGS, profit margins, and quick breakouts of the aforementioned figures.

@MDMDoyle -- Considering the stock fell to $45 today, there already has been a better entry point, but that sort of misses the point of ultra long-term investing. A $5 difference isn't very much when we're talking about decade-long time horizons and likely sizeable returns to compliment.

If the market were to be so kind and give me a significantly cheaper price than $50 on Facebook in the short-term, you better believe I'll be doubling down because I remain committed to the long-term story.

@CoreAndExplore - What other company as massive as Facebook has been able to turn the threat of mobile into a massive opportunity in less than two years? I think this really speaks to the ability of Facebook's management to adapt and deliver meaningful results over the long-term.

Addressing your concern, I've found It's often difficult to project out with a high degree of certainty how much money Facebook (or any company) will earn over an extended period of time. I believe can more easily predict that Facebook's management will likely remain highly adaptable and able to deliver big wins for its business and investors over the next decade.

That's a good point - it is exceedingly difficult to project accurate earnings/revenue forecasts when there are so many volatile variables inherent in those calculations. Facebook certainly has extremely capable management, and a rock-solid corporate culture, which itself warrants somewhat of a premium, but then again, so does Apple. It's all relative, I suppose. Thanks for an interesting article.

Good article, although I do think that FB is too expensive to hold a long position especially considering the fickle nature of social media's short history I do buy into the sheer size of the user community having more future value than traditional metrics will show.

But I did have one counterpoint I wanted to ask you about regarding the mobile add revenue vs total add revenue chart. It's an interesting metric to show that Facebook is monetizing its mobile users, which I remember being a big concern discussed following the IPO. But I don't see how it puts to rest concerns of mobile users cannibalizing desktop oriented users considering revenue has been relatively flat as mobile's percentage share of revenues has increased. It seems to me that when looking at the chart you provided along side a chart of quarterly revenues it shows that any growth FB is showing in mobile usage is coming at the expense of a decline in use of traditional (and it seems, at present, more lucrative) platforms. Wouldn't these concerns only be put to rest if FB could show that it is growing its mobile revenue while maintaining its revenue from other platforms ie Total Revenue increasing in proportion to the increase in Mobile revenue?

I will give you this, Facebook has an amazing cash horde right now for the size of its business/overhead (I think they can stay in business for 35 years if they fail to make another penny). This article does also point out its ability to deliver in a short time frame on mobile (an area of huge concern at the initial IPO).

I find it laughable to say that a 52 week high is a good place for an entry point. I also find it hard to take a decade long forecast on a company that has only existed for 18 months. This is comparable to people extrapolating natural resource deposits of initial testing and assuming that correlates to future profits/growth. Also you have to consider how the new user growth has slowed and the quality of the new users.

I certainly hope you are right, I never want to see anyone lose money, especially a fellow fool. I would love to have gotten in around the 20$ mark but I lost perspective of the business potential and started to question Zuckerberg's ability to be a great CEO.

Perhaps the USA will default next thursday and I can get back in at the 30$ mark.

@cooter1127 -- Initially, the concern was that mobile would cannibalize the desktop advertising model, but it hasn't played out that way.

On a year over basis, Facebook's second quarter total revenue rose (including payments) by over 53%. If you only account for total advertising revenues (mobile and desktop), total advertising revenues rose by nearly 62% in a year.

It's worth noting that the second quarter of 2012 was the first period that Facebook broke out mobile revenues when it represented only 3% of total advertising revenue, making it a good comparable measure of overall advertising growth.

Hope this clears things up.

@MDMDoyle -- Over a 10-year period, a stock on the up-and-up will make many 52-week highs. It's all a matter of perspective. And while true, Facebook has only been public for less than 18 months, it was founded in 2004. Social networking has been around longer than most people realize.

I am still see the massive P/E as a major stumbling block to current and future valuation. Am I wrong in thinking that they would have to increase revenues >20x in order to catch up with current pricing. Even if they were to increase growth of revenue 30-40% a quarter. We are still talking 8+ years to achieve revenue at ? net margin. In that same time the real value of the cash used to buy the investment drops by half due to loose monetary policy and you've just reached target P/E. That being said, I don't believe that it would be reasonable to expect this to become reality.

I also believe that the value of a company being a great place to work at is not a useful factor when the net margin is so low. I simply cannot buy into the idea that valuation should include pride or smugness if the net return is zero. If there is no real growth in assets or income via an investment I see no value beyond warm fuzzy. Warm fuzzy won't grow ones capital unless one can market make people into believing that warm fuzzy is more important than real growth and/or income.

I must say that my hard headed outlook regarding FB valuations is completely due to having taken in far to many obviously market making blog entries, columns and news reports that used partial truths; incomplete pictures; poor logic and pumped up forward looking statements; seemingly to ensure that FB insiders could sell their holdings. Did anyone else notice the hype increase leading up to the start of insider dumping? Obviously the insiders do not see it being a good value for growth at this price level.

I've had a Facebook account since well before it was even released to public (while it was only availble to University students). I am well aware of its stickiness. Extrapolating future growth from a company that basically started at zero earnings is my only warning to new investors who read this article.

As Warrent Buffet loves to point out it's much harder to grow the larger you get. Facebook is struggling to attract new users compared to its years of hyper growth. I expect the same will be true for new advtisement income.

FB's cash horder and corportate culture gives the stock upside if Zuckerberg can find a way to convert innovation into future revenue streams.